NY to regulate CDS market

Beginning in January next year, US authorities will start regulating parts of the credit default swap market.

The massive $62 trillion market, which has up until now been unregulated, was a major contributor to the emerging financial crisis on Wall Street.

The state action applies to credit default swaps which are a means of profiting from falling values of bonds.

New York Governor David Paterson also called on the federal government to help regulate the market.

A credit default swap is similar to a short sale of a stock. In both cases, an investor profits when the value of the security, either a bond or a stock, declines.

The action follows similar moves by the federal government to restrict ‘short selling,’ or profiting from falling stock prices.

The New York Insurance Department issued new guidelines that, for the first time, establish that some credit swaps are insurance and therefore subject to state regulation.

So called ‘naked swaps’ are not insurance and cannot be regulated by the State.

The goal of the regulation is to ensure that sellers have sufficient capital and risk management policies in place to protect buyers.

Major problems were created at AIG when credit default swaps were issued by a non-insurance unit that did not hold sufficient reserves.

‘The absence of regulatory oversight is the principle cause of the Wall Street meltdown we are currently witnessing. While I applaud the recent federal intervention to stabilize the market - and thus our entire economy - it is important we also take the next step as a nation by regulating areas of the market which have previously lacked appropriate oversight,’ said Governor Paterson.

Eric Dinallo, New York State Insurance Superintendant, said: ‘The severity of this crisis was substantially increased by what the government chose not to regulate, principally credit default swaps.’